Benefits to early conversion of RRSP to RRIF

The Registered Retirement Savings Plan (RRSP) is for “saving.”   This savings and tax deferral within an RRSP can continue until the age of 71.  In the year you turn 71, you have to either close your RRSP by either taking the money out, purchasing an annuity or transferring it to a Registered Retirement Income Fund (RRIF). 

From a taxation standpoint, it is rarely advised to de-register 100 per cent of your RRSP in one year and withdrawal the cash.  This would only be advised when an RRSP is very small or there is a shortened life expectancy or financial hardship.   Purchasing an annuity as an RRSP maturity option is a final decision that can not be reversed.  Upon your death, the annuity option often leaves nothing for your estate or beneficiaries.  

For many reasons, conversion of your RRSP to a RRIF is the most popular and flexible method.  Most of your savings will continue to be tax deferred with a minimum withdrawal amount being determined annually based on the previous December 31 value.  In the year a RRIF is set up, there is no minimum withdrawal amount.   All RRIF’s set up after 1992 are considered non-qualifying.  The following minimum RRIF withdrawal amounts are the non-qualifying annual percentage by age on December 31st: 

Age                 Per Cent        

72                    7.48    

73                    7.59

74                    7.71

75                    7.85

76                    7.99

77                    8.15

78                    8.33

79                    8.53

80                    8.75

81                    8.99

82                    9.27

84                    9.93

85                    10.33

86                    10.79

87                    11.33

88                    11.96

89                    12.71

90                    13.62

91                    14.73

92                    16.12

93                    17.92

94 or older      20.00

To illustrate how the above schedule works, we will use 71-year-old Barry Campbell who has saved $1million in his RRSP.  Barry is single and he chose to convert his RRSP to a RRIF account in the year he turned 71 and he will begin taking annual payments next year.  Barry has had years of complete deferral but this is coming to an end.  Based on the above minimum RRIF schedule, Barry will be required to withdraw $74,800 ($1 million x 7.48 per cent) and have this amount included in his taxable income.   Unfortunately, Barry doesn’t have a choice at age 71.  Based on Barry’s total income with the RRIF, he is projected to have half of his old age security clawed back (required repayment) based on his high income.  If Barry were to pass away, the majority of the RRIF would be taxed at 45.8 per cent.  Unfortunately, Canada Revenue Agency (CRA) would receive nearly half of Barry’s lifetime savings within his RRIF.   

We feel it is important for clients to understand the taxation of a RRIF in a most likely scenario of normal life expectancy and shortened life expectancy.   RRIF accounts for couples greatly reduce the taxation risk of shortened life expectancy by being able to name your spouse the beneficiary and avoid immediate taxation of the full account balance.  In 2007, CRA introduced pension-splitting, which provides taxation savings for most couples with eligible pension income. RRIF withdrawals at age 65 or higher are considered eligible. 

Beginning in 2009, CRA introduced the Tax Free Savings Account (TFSA) that provides tax savings for individuals and couples.  The savings is a result of all income (interest, dividends, and capital gains) generated within the TFSA not being taxed ever.  There is no taxation upon your death.  The amount that can be put into a TFSA is limited by a relatively small amount each year. People who are serious about saving for retirement often contribute to both an RRSP and TFSA.

Given the introduction of pension splitting and the TFSA, many people should be looking at converting their RRSP to a RRIF before the age of 71.  When we are helping clients with the optimal time to convert their RRSP, we look at their marital status, health/genetics, and other investments.  With other investments, we create two baskets (A and B) to analyse what we call the “bulge.”  A bulge is when you have too much concentration in either basket A or B.  Basket A is the total amount in your RRSP accounts.   Basket B would include bank account balances, non-registered investments, and your TFSA – none of which will attract tax on the underlying equity if used.  Basket A may also include your principal residence if the intention is that this will be sold and the capital used to fund retirement.  

We caution investors not to create a bulge – having too much in either basket means you may not have the right balance as you enter retirement.  Taking advantage of deferral opportunities over time often makes sense.  Having too much in basket A means you may have very little flexibility if an emergency arises and you need cash (new roof, vehicle).   If A / (A + B) is greater than 75 per cent (a bulge) then we would recommend you speak with an advisor to determine in you should convert your RRSP to a RRIF early.  Above, we noted Barry has $1 million in basket A.   Barry also has $250,000 in basket B.  With these numbers Barry has a bulge percentage of 80 per cent. 

A financial plan prepared while you’re working largely results in savings strategies to reach your retirement and other goals.  In retirement, a financial plan is prepared to create withdrawal strategies that are tax efficient and smooth out your income during your lifetime.  They can also be prepared in conjunction with estate planning.   

Kevin Greenard CA FMA CFP CIM is an Associate Portfolio Manager and Associate Director with The Greenard Group at ScotiaMcLeod in Victoria.  His column appears every second week in the TC.  Call 250-389-2138.